Question

Michael Porter has argued that "the intensity of competition in an industry is neither a matter of coincidence nor bad luck. Rather, competition in an industry is rooted in its underlying economic structure." What does Porter mean by "economic structure"? What factors besides economic structure might be expected to determine the intensity of competition in an industry? Source: Michael Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York: The Free Press, \(1980,\) p. 3 .

Short answer

Porter's 'economic structure' refers to the composition and operation of an industry, including aspects such as number and size of competitors and market conditions. While this structure significantly influences competition intensity, other aspects like government regulations, technology, socio-cultural trends, customer loyalty, and business cycles can also play a role.

Step-by-step solution

Understanding Economic Structure

Economic structure refers to the way an industry or market is organized and operated, encompassing factors such as the number of competitors, their comparative sizes, and their influence over market conditions. This might include barriers to entry, the degree of product differentiation, and the presence of economies of scale.

Porter's view of economic structure

According to Porter, the intensity of competition in an industry is predominantly determined by its economic structure. That is, the nature and degree of competition are largely influenced by factors inherent to that industry. This could involve the level of supply and demand, the number of competing firms, and the market share distribution, among other things.

Factors beyond economic structure

While the economic structure is a significant determinant of competition intensity, other factors can also have an impact. These could include, but are not limited to, government regulations and policies, technological advancements, socio-cultural trends, the magnitude of customer loyalty, and the level of business cycles.

Key concepts

Economic Structure

Economic structure is like the backbone of any industry. It defines how an industry is organized and functions. Imagine a blueprint that shows you the construction of a building; similarly, economic structure outlines the setup of an industry.

Key aspects of economic structure include:

• The number of competitors in the market
• The relative size of each competitor
• Their ability to influence market conditions

These elements shape the playing field for businesses. Economic structure also considers barriers to entry, which are obstacles that make it difficult for new companies to enter the market. It looks at product differentiation, or how products stand out from each other. Additionally, it includes 'economies of scale', which means producing goods becomes cheaper as output increases.

In essence, economic structure is a snapshot of how an industry is set up to run, influencing how businesses interact and compete with one another.

Industry Competition

Industry competition refers to the rivalry between businesses striving to attract consumers and increase their market share. It’s the race to be the best provider of goods or services in a specific market.

This competition is not random. As Porter notes, it’s heavily influenced by the existing economic structure of the industry. Factors like the number of competing firms, how balanced they are in terms of size or market power, and the speed of industry growth all play significant roles. These factors decide how fierce or gentle the competition will be.

Sometimes, high competition can drive innovation and improve service quality. However, extreme competition can also lead to market instability or crowded markets where profits are hard to achieve.

Barriers to Entry

Barriers to entry are factors that can discourage or prevent new competitors from easily entering an industry or area of business. Think of it as a moat surrounding a castle; only those who can bridge the moat can enter.

Barriers can include:

• High startup costs making it expensive to start a new business
• Strict regulations that new companies must comply with
• Established brand loyalty that new entrants struggle to compete against
• Control over essential resources by existing players

These barriers ensure that only firms with specific advantages or resources can join the market. They help protect established companies from new competition, thereby maintaining the market's existing competitive balance.

Product Differentiation

Product differentiation is how companies make their products or services stand out from the competition. It's about creating uniqueness, whether through special features, superior quality, or branding.

Key elements include:

• Features: Does the product have unique characteristics?
• Quality: Is the product of superior quality that competitors cannot match?
• Branding: Does the company have a strong brand image that adds value to its products?

These elements enable companies to attract and retain customers, offering them reasons to choose one product over another. Through effective product differentiation, a company can not only compete efficiently but also command higher prices for their unique offerings.

In competitive markets, differentiation becomes a strategic tool, helping firms carve out their niche and reduce direct competition.